Japan’s inflation data for July 2025 revealed that the Consumer Price Index (CPI) in the Tokyo area was at 2.9% compared to the same month last year. This number was slightly lower than the expected 3.0% and down from June’s 3.1%. The core CPI, which excludes fresh food, also reached 2.9%. This matched expectations but fell from the previous month’s 3.1%. Meanwhile, the core-core CPI, which excludes both fresh food and energy, remained steady at 3.1%, consistent with forecasts and prior results.

Bank of Japan and Interest Rates

The Bank of Japan believes inflation hasn’t hit its target yet, which means it will hold off on raising interest rates. The Japanese economy faces challenges from tariffs. Market expectations hint at a possible rate hike by late 2025 or early 2026. Opinions vary; some corporate analysts foresee longer delays. A new US-Japan trade deal could pressure Japan’s economy further, leading to no rate changes until mid-2026. Recent data from Tokyo supports the central bank’s cautious approach, allowing it to postpone interest rate hikes. The slight drop in inflation suggests that the bank will continue its wait-and-see strategy. This creates a larger gap between Japan’s interest rates and those of other major economies, like the United States.

Currency and Market Implications

This situation favors a weaker yen, making it a good choice for funding carry trades. Historically, the interest rate difference between U.S. and Japanese 10-year government bonds has influenced currency movements. For example, in early 2024, this gap surpassed 350 basis points, causing the yen to reach multi-decade lows. Therefore, we will maintain and increase positions that benefit from further yen declines, such as long USD/JPY call options. The information shows that inflation, excluding food and energy, remains high and unchanged. This puts the central bank in a tough spot—though it wants to hold off, stubborn prices might force it to act sooner than expected. We believe that this divergence means that market volatility is currently underestimated, and traders should think about buying options, like straddles on the Nikkei 225 or currency pairs, to profit from potential sharp movements in the market. The idea that a slowing economy could keep the Bank of Japan on hold until mid-2026 is becoming more plausible than the general market belief. Japan’s Cabinet Office recently reported that the economy narrowly escaped a technical recession in late 2023, highlighting its underlying weakness. This fragility supports the expectation of lower interest rates for a longer period, through tools like Japanese government bond futures. Create your live VT Markets account and start trading now.

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